How To Make A Promissory Note To Fund Your Small Businesses

Borrowing money from friends and family is a frequent method of financing when starting a business, and during the early stages of growth. A promissory note is a very common legal document that a business owner signs to legally formalize the borrowing arrangement.

In this article we go in depth on how to make a promissory note, the issues you need to understand before borrowing money using a promissory note, and templates/services that can help you put together your promissory note.

Did you know? If you have more than $50,000 in your retirement account you can use this money to start or buy a business without paying early withdrawal penalties. Click here to learn more.

What A Promissory Note Is (and what it’s not)

A promissory note is a promise by the promissor (the borrower) to pay a specified sum, within a defined period of time, to the promisee (the lender).

A promissory note may or may not contain a schedule for repayment. The promissory note must be signed by the promissor (the borrower). Promissory notes tend to be unsecured debt, meaning there is no collateral provided by the borrower in the case of default.

Promissory notes are generally thought of as one step above an IOU, which is a signed acknowledgement that the author owes a certain amount of money. Unlike a promissory note, an IOU does not include steps towards repayment, such as when, and in what increments, the money needs to be paid back.

Promissory Notes: Business vs. Personal

There are two primary ways you can borrow money when using a promissory note. Which method you use has very important legal consequences:

You can be a party to the transaction personally, and borrow the money in your personal name. (checks are written out to you personally).

Your business can be a party to the transaction. (checks written out to your business)

Borrowing Money In Your Personal Name

Many people start borrowing money before they legally establish a business. Those that have already established a business may also be able to take a personal loan, and invest the funds in the business.

In this case, the transaction must be a person to person transaction, meaning you cannot accept money from a business, it has to come from another individual. Regardless of what happens to the business, the promisee (borrower) has made a promise to pay back the promissory note.

When borrowing money as an individual from other individuals, you are subject to the federal trade and anti-fraud laws/ However, our research indicates that there are no specific forms that need to be submitted to governmental authorities to borrow for a personal promissory note.

Personal Promissory Note Templates

If you type in “free promissory note” in a Google search, you will get dozens of results, ranging from a promissory note template from Suze Orman to a promissory note template offered by CreditCard.com. While I am not a lawyer nor have asked a lawyer to review these promissory notes, they seem less comprehensive than those offered by paid services such as TrustLeaf or Rocket Lawyer.

According to Form Swift and Wikihow, here are some important elements of promissory note. If the promissory note that you find online doesn’t have these you might want to move on!

The words “Promissory Note” in the header or top of the document.

Identification of the both parties involved, including full legal names and addresses.

Terms – amount being borrowed, interest, and the amount and timing of payments.

Description of the penalties for late payments.

Right to transfer clause – giving the “lender” the right to sell or give their rights to receive payment to another individual. (if you’re the borrower, you might want this to explicitly state that they don’t have the right to transfer)

Signatures for the promissor (borrower), promisee (lender) and witnesses / notary. In lieu of a witness, notary signatures can be collected by secure online signature.

While not mentioned in the sources above, its also should state which laws govern the agreement, ie The State of New York.

We Recommend Using TrustLeaf

The forms provided by Trustleaf appear to be very detailed and are worth a look. As this is a serious transaction it is worth using a professional service, and the costs are minimal.

Keep in mind that these templates are all for PERSONAL promissory notes. If you want to borrow money in the name of your business keep reading.

Borrowing Money In Your Business Name

Instead of borrowing money in your personal name, you can use a promissory note to borrow money in the name of the business. If a business borrows money and is unable to pay it back, the business owner may not (depending on the terms of the promissory note) be on the hook for paying it back.

There are other reasons why a business owner might want to borrow money in the name of the business, instead of in their personal name:

The business may have multiple owners, which can make borrowing and paying back money as a business simpler.

The business may be better (less risky) or easier to evaluate as a borrower by potential lenders than the business owner(s).

The business may be able to advertise that its looking to raise money (more on this below).

Once a business borrows money from individuals, the promissory note is considered a security. This makes things more tricky, as securities are subject to both state and federal laws, unless they qualify and file with the SEC for exemptions.

Most small companies raising capital using a promissory note (or other forms of debt or equity) take advantage of exemptions to avoid big legal bills and lots of paperwork. There is still work involved in deciding on which exemption you want to use, and filing the exemption paperwork with the SEC and state authorites.com

If you are going to raise money in the name of your business we suggest using a securities lawyer or service like InvestNextDoor.com who can help you with the paperwork.

We are not lawyers, but here is a general overview of how exceptions work.

Small Business SEC Exemptions When Raising Funds

Unless a business is going to do a registered securities offering with SEC, they are going to need to choose and comply with an exemption from securities registration requirements. The most common exemption is Rule 506 of Regulation D.

Exemptions place restrictions on the fundraising process. Restrictions on the fundraising process can include how much money can be raised, over what period, who can invest, what information must be provided, and if marketing can occur. (Most exemptions disallow advertsing. Rule 506(c) Reg D is the exception to this general rule and allows for marketing or general solicitation).

Want to able to raise money from people that aren’t accredited investors? Then you generally aren’t going to be able to do generally solicit the offering. (The Jobs Act was supposed to change this, however, the SEC has yet to provide the new regulations.) Advertising securities offerings is one of those things you do not want to do without consulting a lawyer.

Conversely, if a business owner wants to approach investors or advertise the opportunity, the business owner is only going to be able to take money from accredited investors.

What is a general solicitation?

Putting a banner ad online, mentioning raising money on facebook, or talking about raising money to a reporter would constitute as general solicitation. I asked attorney Joe Wallin if a business owner could send an email to everyone in their address book about raising money without it being general solicitation. He indicated that an email sent to hundreds of names would make him extremely uncomfortable, even if the sender knew everyone who was receiving it. The reason is that in such a situation it would be very hard to control what happened to information provided in the email after the send button was hit.

The Bottom Line

Before borrowing money via a promissory note, make sure you consider the consequences of borrowing money in your personal name, or in the name of the business. If you borrow money in your personal name we recommend checking out Trustleaf.com. If you borrow money in the name of your business we recommend using an attorney or service like InvestNextDoor.

Did you know? If you have more than $50,000 in your retirement account you can use this money to start or buy a business without paying early withdrawal penalties. Click here to learn more.

About the Author

Marc Prosser has been involved in many businesses as an executive, advisor, and investor. Prior to starting his own company, Marc Prosser was the first employee and Chief Marketing Officer of FXCM. During his ten years at FXCM, the company grew from a small business to over 700 employees.

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Comments (7) • Likes (0) Disclaimer: Reviews on FitSmallBusiness.com are the product of independent research by our writers, researchers, and editorial team. User reviews and comments are contributions from independent users not affiliated with FitSmallBusiness.com's editorial team. Banks, issuers, credit card companies, and other product & service providers are not responsible for any content posted on FitSmallBusiness.com. As such, they do not endorse or guarantee any posted comments or reviews. LikeAsk a Question

I attended a small business accounting workshop last night. Today I started researching a few details I recently overlooked. You pointed me in the right direction (TrustLeaf)! Thank you for such rich content.

Hi Win, Thanks for the compliment. Given the billions of dollars that invested by family and friends in startups and small businesses, its surprising that there a so few resources for these types of transactions. Good luck, Marc

Marc, The definitive guide to raising business capital from family members and friends was written 10 years ago by Asheesh Advani and the Nolo Press: “Business Loans From Family & Friends: How to Ask, Make It Legal & Make It Work” It’s still available on Amazon and worth every penny. Jim

Jim, I have the pleasure of personally knowing Asheesh Advani. He is the CEO of a company called CoVestor, which provides investment product to individuals. I will invite to post a comment on this article! Best, Marc

Jim, thanks for the shout-out. Glad you liked the book. Marc, nice post. I think the only thing I would add is that borrowers should avoid lump-sum payments in loan repayment schedules since they tend to cause defaults and misunderstandings. It’s better to make some monthly payments (however small) since it creates a habit of repayment. Best, Asheesh

Thanks Asheesh for adding the insight. Making small regular (weekly or monthly) repayments is better than big (quarterly or annual) repayments. It makes sense! It’s easier to come up with a little money like a few hundred than find several thousand dollars at once. Best, Marc

This is great. I had no idea that such notices could be constructed when borrowing money from family or friends. Would think would increase the chance of getting the money back and lay out exactly what both parties want.

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